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US election implications for emerging markets

Despite episodes of tough rhetoric from both US presidential candidates on world trade, a Hillary Clinton victory will likely lead to business as usual trade policies, but not everything will be business as usual under a Clinton administration. However, under Trump, world trade could come under serious strain. Gary Greenberg, Head of Emerging Markets at Hermes Investment Management, explores the impact on emerging markets of either Hillary Clinton or Donald Trump entering the White House.

The upcoming US election could have significant consequences for world trade and geopolitics, and therefore for emerging markets. Democratic nominee Hillary Clinton is ahead in polls of the popular vote, while further ahead in the Electoral College. However, polls have recently been poor predictors of election results, so it is prudent to consider the consequences of both candidates’ accession.

Both candidates seem likely to propose fiscal stimulus targeting infrastructure. Clinton would pay for this through higher taxes and a pension-fund-supported infrastructure ‘bank’, and Trump through a dedicated infrastructure fund backed by government bonds. But don’t expect a big boost in US GDP growth: Trump’s deficit spending would cause panic in the bond market, and Clinton’s spending package would struggle to get through a Republican Congress. Both would likely grant a tax break to domestic corporations in order to reel in cash from US businesses operating overseas, though the predictable success of lobbying efforts would ensure this repatriation is unlikely to result in much tax revenue.

Clinton represents business as usual on trade, notwithstanding her grandstanding on the North American Free Trade Agreement (NAFTA) to appear tough on trade policy, and proposing changes to pending agreements such as the Trans-Pacific Partnership (TPP). The TPP represents America’s last shot at maintaining commercial (and strategic) sovereignty over the Pacific. But Clinton’s “Pivot to Asia” has been unwound by Duterte’s “Pivot to China”. We are not likely to see trade wars under Clinton, but military tensions in the Pacific are likely to escalate. Trump would, of course, renounce both pacts, with immediate economic shocks for emerging markets.

Impact goes beyond a Mexican wall

China and Mexico enjoy large trade surpluses with the US, representing just over 1.5% and 0.6% of US GDP respectively. If elected, Trump could restrict imports, as threatened, primarily targeting these two countries. The US Treasury could brand China a currency manipulator, potentially leading to countervailing duties on Chinese imports, which generate just over 2% of China’s GDP. Trump could exit NAFTA, possibly even without congressional approval, compromising exports accounting for about 9% of Mexico’s GDP. Building a wall might help Cemex, but this would be cold comfort in a very uncomfortable situation.

If Trump decides not to target individual countries, he could aim to make good on his threat to leave the WTO, although this is likely to require congressional approval. Other emerging markets whose exports depend significantly on US demand include Thailand, Korea and Malaysia.

A further economic blow to emerging markets would result from Trump’s aim to block or even appropriate remittances, particularly to the Philippines, where it finances 3.5% of GDP, and to Mexico, where it accounts for just under 2%.

Geopolitical turbulence and energy policy

Geopolitically, a Trump-led withdrawal from foreign engagements could encourage more aggressive activity by America’s traditional rivals, China and Russia. For global trade and stability, the great concern of an isolationist, America-first Trump presidency is the reversal of US foreign policy commitments made in the last 70 years, which focused on keeping the sea lanes open and secure for all, preserving European peace and protecting Arab oil exporters.

With the US exerting less global influence, any improvement in Russia’s geopolitical position may be partially offset by Trump’s domestic energy policy. He would likely focus on maximising domestic oil and gas production by abolishing the regulations increasing drilling costs and accelerating exploration and development on federal lands and offshore areas – prohibited under the Obama administration.

More US production would mean lower energy prices globally, which would harm the economies of the Middle East, Russia, and Mexico – but would benefit the majority of emerging markets, which are mainly oil importers.

Clinton is the more muscular of the two candidates in terms of foreign policy and could shift the balance of power in the Middle East. A US leader prepared to defend a “line in the sand” could create surprising outcomes. Russia’s economy continues to suffer under the twin burdens of sanctions and $50 oil, and Putin’s popularity would be better served by economic growth than continued recession. Why not cut a deal, giving up bargaining chips such as the brutal bombing of Syrian cities, and perhaps Assad himself, in return for the relaxation of sanctions? Even Turkey’s Erdogan, faced with a much tougher US partner, could prove more amenable to cooperation, once the Syrian thorn was removed from his side.

China tensions and global fallout

If the US entered a trade war with China following a Trump victory, perhaps sparked by increasing tension in the Straits of Taiwan, it would lead to significant losses for both economies. Unemployment in China could rise to levels that threaten social stability, and in response the authorities could then impose capital controls, change the composition of its foreign-exchange reserves to include fewer US Treasuries, and restrict access for US firms. US import prices could rocket, causing inflation and a housing market relapse. US stocks would move lower to discount this difficult scenario.

China’s central bank has enough firepower to manage the pressure caused by a protectionist US, but the rest of Asia would find it difficult to adjust to lower trade surpluses and possibly weaker security. A US-China trade war would likely have global consequences, driving Asian exporters into steep downturns and potentially causing a worldwide recession. Of course, the risk of the new Cold War turning hot under Clinton is not negligible, and periodic sparks or face-offs would keep investors nervous.

Markets outside the US would not celebrate a Trump victory. Global bond prices would likely tumble due to his willingness to countenance a budget deficit of 10% of GDP, and stocks would follow suit as investors discount the threats of new tariffs, an exit from the WTO and a trade war with China. The deficit and trade war could lead to higher interest rates and a stronger dollar, neither of which are associated with strong emerging market stock markets or currencies. If yields on US Treasuries rise, those on emerging market sovereign debt would also climb higher. Trump’s bombastic politics may be ugly, but the economic consequences of him governing the world’s largest economy would be worse.

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Gary GreenbergHead of Hermes Emerging MarketsGary Greenberg joined Hermes in September 2010 in the Emerging Markets team. Previous to this, he was Managing Partner at Silkstone Capital and Muse Capital, both London-based hedge funds he co-founded and managed in 2007 and 2002, respectively. From 1999 through 2002 he was Executive Director at Goldman Sachs in New York and London, where he co-headed the Emerging Markets product for GSAM, and served on the global asset allocation and European stock selection committees. From 1998 to 1999 he was Managing Director at Van Eck Global in Hong Kong and New York, where he was the lead portfolio manager for International Equities and ran the Hong Kong Office. From 1994 through 1998 Gary was Chief Investment Officer at Peregrine Asset Management in Hong Kong, managing and supervising global and regional equity, plus fixed income funds. In the early years of his career he was a Principal of Wanger Asset Management in Chicago, where he co-founded and co-managed the Acorn International Fund, which grew to $1.4 billion under his tenure. Gary holds an MBA from Thunderbird School, a BA from Carleton College and is a CFA charterholder. Read all articles
by Gary Greenberg